Private sector investment in energy lending and climate finance

Tuesday, Sept 28, 2010, 9am to 2:30pm

Bretton Woods Project/ ActionAid Offices, 33-39 Bowling Green Lane, EC1R 0BJ

I. Over-view of role and types of private sector finance- Kate Geary, Oxfam, Climate Change/Private Sector Policy Adviser

Background to Climate Finance (CF):

At Copenhagen it was agreed to mobilise $100bn from public and private sources for investment in clean technology.

NGOs have been calling for 100% public finance to make up the $100 bn but Ministers stated at the Geneva Ministerial in September that if $10bn public finance leverages $90bn private finance then they have achieved their target.

Types of Private Finance

Very broadly, there are two kinds of finance – loans (or debt financing) and equity. Loans earn money for the lender – usually banks – by being repaid; whereas equity finance means taking a stake in the project or company itself, so demands a higher rate of return (IRR).

• The simple fact is: it’s not happening.
• If left to its own devices, will flow to more developed nations and established sectors – as the Clean Development Mechanism shows
• Risk is a key issue: investing in developing countries is risky; investing in new/green tech is risky; and adaptation is neglected. Types include financial risk, currency risk, country and political risk, tech and project specific risk.
• Rates of return demanded will be very high for developing countries. AGF example: developed countries: 9-11%; Mexico: 15-17%, Turkey: 20-25%; West Africa: 40-60%.

Table showing public interventions/mechanisms to leverage private finance

Questions to consider:

How can we make Private finance accountable?

What, if anything, should count towards the $100bn total?

II. The CIFs and MDB private sector leveraging instruments for climate finance –

Melinda Bohannon & Radhika Bharat, DFID

Radhika

Radhika repeated the need for private finance.

• Private sector has two roles to play:
  • Provision: Innovation, manufacturing, installation and operation of clean infrastructure
  • Financing: Private investors, particularly Institutional investors such as pension funds, sovereign wealth funds, insurance companies and foundations are part of the solution given their objective to make investments both in the short and long term.
• The Public Sector has a key role to play in leveraging in investment:
  • Policy dialogue with recipient countries
  • Financing instruments, including concessional funds

Melinda Why do MDBS need to be involved in leveraging private sector investment?

1. They provide instruments that can address barriers

2. MDBs have many decades experience in other sectors of leveraging PS involvement – lessons can be learnt and applied to climate change

3. Private investors derive comfort from MDB involvement – not just for credit ratings etc but also for on-the-ground knowledge and contacts.

Private investors also favour carbon finance (through carbon markets) as this guarantees revenue – so this is an area where MDBs have a growing role.

MDBs primary interest is that investments must not jeopardise their AAA rating.

Mel explained that DfID had commissioned GBRW consulting to prepare a report to find out the role of MDBs in CF. This has not been adopted as DfID policy, but will guide it. This is a new area for DfID and knowledge is still being built, but tentatively it looks as though DfID would like to focus on getting the MDBs to get more involved in equity and guarantees. The results from the report are shown in the following matrix…

A question DfID is considering is: Should there be a more streamlined way of accessing funds? We are encouraging them to see what more they can do.

At present, as can be seen from the chart on Development Related Expenditure, the vast majority of transfers occur as loans, whereas leveraging of private finance is better done by guarantees (against risk) and equity investment. This is why DFID might in future emphasise the need for an increasing role for MDBs in providing guarantees and equity.

Radhika

• The Climate Investment Funds (CIF), are a collaborative effort among the MDBs and countries to bridge the financing and learning gap between now and a post-2012 global climate change agreement.
• Governed by balanced representation of donors and recipient countries
• A sunset clause enables closure of funds once a new financial architecture has become effective.

There are two main windows within the CIFs to channel climate finance: the Strategic Climate Fund and the Clean Technology Fund (CTF). This talk will focus on the CTF given the stronger involvement of private sector in these.

• In all cases the objective of CTF funds is to reduce the barriers for early market entrants such that additional investors, developers and financial intermediaries will subsequently enter the market without additional CTF support
• Catalyses and pilots ambitious low and zero carbon technologies in up to 15 countries
• Delivers improvements in renewable energy, energy efficiency and transport efficiency and so:
  • Accelerates transformation to low carbon economies
  • Reduces emissions

CTF funds are used to encourage investors to undertake projects they otherwise would not or to fast-track the scale-up of such projects.

Overall leverage of CTF is 1 to 8 (1:3 of CTF+ MDB to private sector leveraging)

Intro to Climate Public-Private Partnership (CP3)

• A potential public-private partnership to mobilize private equity investment at scale in low carbon and resource efficient infrastructure in Asia
• UK’s DFID, ADB and IFC would work jointly with institutional investors
• Address knowledge gaps arising from market failures
• Invest in early stage project equity
• Clear commercial and financial objectives: program to invest alongside ADB and IFC benefiting from their track records, local knowledge and access to risk mitigation tools
• Key sectors for investment : clean and renewable energy, energy efficiency, waste management, water treatment, transport and Land use
• Leverage: Private sector expected to invest 8x public money

Q&A session

It emerged that: CP3 is still in the design stage. DfID sees CP3 and MDB leveraging as complementing each other. The CP3 governance and accountability structure is still under development and will be clearer in 6 months. DfID is considering carefully how to ensure adherence to its environmental and social standards. If the process is too cumbersome the private sector will simply not invest. Thus the preference is to design a structure such that investment decisions do not have to be approved by MDB Boards or Donors. However, the exact structure will have to balance the private sector’s need for efficiency and nimble decision making and DFID’s need to ensure strong governance and accountability and Environmental and Social standards.

It is possible that this model will be replicated for Africa.

III. The IFC in energy and climate investment (roles and operations) —

Ajay Narayanan, IFC, Head of Climate Change and Sustainability, Global Financial Markets Department

The IFC has three investment streams based on the nature of clients- Financial Intermediaries, manufacturing and agriculture, and infrastructure and natural resources. Climate Business is mainstreamed across all three of these business lines. This presentation largely focuses on financial intermediaries (FIs). A climate business group has been set up within the IFC a month ago.

IFC has a significant business focussing on financial intermediaries where the development impact is associated with reaching SME. IFC direct investments tend to lend to larger projects than can be reached through FIs.

Climate change financing can be applied to almost any form of economic activity. The only thing that is different in climate finance (CF) is assessing ‘end-user proceeds’. Currently there is an absence of projects eligible for investment. Ajay stated that while the availability of money is important to scale up the market and achieve development outcomes, a major requirement is the availability of pipelines of climate friendly projects.

IFC aims to triple its climate investments from $1bn currently to $3bn by 2013.

The IFC’s goal is to get Financial Intermediaries (FIs) to increase their investments in climate finance. IFC estimates that a significant part of the financing for climate change will need to come from banks – whether local ,regional or global, as there is not enough public funds to meet the requirements for a low Carbon development path in emerging markets.

FIs are good to work with because:

• Small and medium enterprises are a major source, best reached through financial intermediaries (FIs).
• Significant scale up through FIs has huge market and development impact
• Creating a market that endures beyond IFC’s intervention by working with the local financial sector

An important aspect of working through FIs is leverage and IFC provides $1m to an FI, that FI’s CF portfolio must increase by at least 1-2 times that amount. When IFC works with an FI on climate business IFC focuses on the use of proceeds of IFC funds. IFC does carry out environmental and social reviews and reputation risk screens on the overall FI operations but does not focus on the other operations of the FI and whether they are used for clean energy or climate friendly investments or not.

When we talk of CF it is a broad area. CF can reach throughout the economy (e.g. wind power, home insulation, efficient appliances, public transport, renewable energy etc).

There are clear eligibility criteria for the end use of IFC funds to ensure they are climate friendly.

The necessary and sufficient conditions for CF to work in a market are:

• Presence of a market
  • Tagging : Existence of a pipeline of projects to finance (short term)
    • In the FIs portfolio (that they are anyway doing either knowingly or otherwise)
    • In the market that is happening with partial FI involvement but could expand if financing is eased up.
  • Partnerships Potential for a new Pipeline (medium term)
    • Market potential with local project development players to expand the market
• The “asset class” being an acceptable risk to the FI (Risk perception)
• FI’s willingness to take the additional effort to record and track the eligibility and monitoring requirements (to retain the integrity of the product) (transaction cost)

The aims are:

• Signalling through the financial sector that investment in climate friendly projects is a good thing.
• Accelerating the use of climate friendly technology.

A large number of financial products are used in this process including subordinated risk sharing, long terms credit lines, trade finance etc.

Some of the instruments used are:

IV. Trade finance- For trade transactions where Parties don’t wish to take each others credit risk, IFC helps broker the deal and build trust through its involvement via FIs

V. Risk sharing facility- IFC takes on some of the risk to overcome the FI’s risk perception that are the barriers to investment. Credit line- IFC gives money to a bank to develop a portfolio of climate products/ lending for the amount of money provided by IFC. This product addresses the ssset liability matching and liquidity for projects with longer paybacks

IFC is working on other products that can be used depending on what it would take for the market to move to finance climate friendly investments based on the risk perception of FIs and the market.

Q&A Session

The proportion of lending from the IFC is approximately 60% to energy efficiency and cleaner production, and 40% to renewables. In terms of proportions to different sectors, approx. 35% goes to each of financial intermediaries, infrastructure and agribusiness/manufacturing.

When asked a number of questions about accountability and transparency Ajay stated that there is a consultation process going on to improve accountability and transparency. There are commercial rules, which prevent the IFC disclosing information that companies don’t disclose themselves. The IFC is trying to overcome this in the new disclosure policy and updated performance standards to ensure increased transparency to create private sector best practice while ensuring consistency with banking and financial regulations.(However, this remains a significant concern for civil society.)

One problem in being too careful with transparency is that if everybody has to be convinced that every dollar was squeaky clean, the transaction costs would be extremely high. He stated that he does not have the solution to this problem but the new disclosure policy will take a step in the right direction to find the balance between best practice for private sector disclosure while ensuring compliance with governance, banking and financial regulations

When asked what questions he thought NGOs should be asking he said the main thing was to familiarise themselves with the instruments, as it seemed that many in the room were struggling to understand how the different instruments he discussed worked. There is also a need for NGOs to better understand the nature and development impact of working through FIs in the private sector. IFC will also be working to increase this awareness through its communication on the disclosure policy, the new E&S risk management frameworks and its communications on development impacts.

IV The ECGD and investment in energy and climate –

Nick Hildyard, Cornerhouse

Export credits underwrite 10% of world trade – far exceeding anything the MDBs do: $260bn worth.

Divided into short term (2 years) and long term (up to 15 years) cover.

Following the Corner House/Campaign Against Arms Trade judicial review of the decision to terminate the Serious Fraud Office’s investigation into alleged bribery by BAE in its dealings with Saudi Arabia over the ECGD-backed Al Yamamah arms contract, BAE withdrew its ECGD cover for its Saudi contracts. As a result, ECGD’s backing for arms now constitutes less that 1% of ECGD’s business.

Nick explained the Export Credit Guarantees Department (ECGD) as working in the following way (although there are variations on this theme):

When a British company X wants to sell a product to company Y in a poor country, it may need the product to be paid for up front in order to pay for production costs. Here, company X will go to bank Z in Britain and ask for the bank to loan the necessary amount to company Y. However, there is a danger that company Y will default. Here, the ECGD steps in and says that if company Y defaults, the ECGD will give bank Z the lost money. Typically, if company Y defaults and the ECGD has to pay the bank back, then the British government will add this amount to the poor country government’s debts.

93% of the debt owed to Britain by poor countries was built up trough ECGD credits.

Private companies can also take poor country governments to court. E.g. Enron in India.

In effect, the ECGD credits are a subsidy from poor country governments to Western banks and producers.

The ECGD is one of many Export Credit Agencies (ECAs) in the world. Many OECD countries and China also have ECAs. Collectively they underwrite 10% of world trade.

ECAs have historically been very competitive and try to undercut each other. In 1978, the OECD countries negotiated a non-binding agreement, known as the OECD Arrangment, in order to establish a level playing field for member state export credit practices. Under the new rules, OECD member ECAs agreed that:

premiums would be risk based;

premiums would cover operating costs and losses;

and ECAs would be required to break even “in the long term”.

Under WTO rules any export credit (EC) which meets OECD Arrangements does not constitute a subsidy. But it is an open secret that the rules are being flouted. ECGD uses an off balance sheet special purpose vehicle to refinance certain export subsidies, but its accounts are not consolidated with those of ECGD. Cornerhouse and Campaign Against Arms Trade have argued that this breaks the WTO rules and are challenging this through the European Commission.

ECGD deals are often secret. E.g. BAE in Saudi Arabia.

Until recently 80%percent of ECGD were in arms exports (notably BAE systems) and aircraft (Airbus). ECs for arms have reduced since the Saudi-BAE scandal. Last year, Airbus accounted for 90% of ECGD’s business. Airbus used to be owned by BAE.

Given the value of support that BAE/Airbus have historically enjoyed, ECGD has been nick-named BAE’s “bank”.

ECGD only introduced environmental and social guidelines in 2000., due in large part to public pressure over ECGD’s involvement in a number of controversial projects.

Internationally, OECD member states have now agreed a set of common environmental and social standards known as the Common Approaches. These require that projects with repayment periods over two years must be screened and must meet the ten World Bank safeguard standards. But there are serious questions over how far these standards are implemented.

Solely as a result of pressure from civil society there is now an attempt to monitor the carbon footprint of the ECGD projects. Tony Blair announced in Johannesburg in 2003/4 that £50m will go to renewables. Not a penny of this has been spent.

Reasons for this money not being spent include:

1 – ECGD responds to requests from exporters: its support is thus “demand led” and there has been no demand for such support, not least because the UK doesn’t have a renewables industry to speak of

2- More generally, the OECD Arrangement contains a number of rules that some see as unfavourable to green exports. For example, it typically does not allow for more than 15% local content to be funded. But many renewables involve more local content than this (wind farms often involve 25-70% local content).

3 -The ECGD also requires that the exports it backs contain at least 20% UK content. So if a company is involved in the design, logistics and consultancy for a renewables programme, rather than in the manufacturing of parts, ECGD may have difficulty in backing it. (By contrast Denmark allows 100% foreign content).

Producers of renewable technology all say they want two things:

1) The government to end the subsidy of fossil fuels. A lot of ECs go here. E.g. Shell in Nigeria.

2) The government to start policies to stimulate renewables.

– Its unlikely that the ECGD can be reformed. Things Nick would like to see are:

– The govt putting money into a green investment bank.

– The development of export credit mechanisms that do not involve sovereign counter guarantees – and hence poorer countries paying for non-performing exports.

– Clean technologies which should be transferred to the South but this should not be done in a way which subsidises the North.

Role of private equity in renewables investment:

– private equity invested in wind farms/solar needs huge rates of return – so unlikely to charge an affordable tariff to poorest people

– Risk of ‘fad’ finance – private equity follows trends: when the clean tech bubble bursts, as it is likely to do, there is a risk that money will flood out of this sector and move on to the next ‘fad’

– Private equity does not flow to the poorer countries, but to richer developing countries eg China, India and Chile

– Central to the expending use of private equity is the issue of control and access; local communities should be the ones to have control over and access to renewables, not the likes of Blackstone and Carlisle.